You may be a young person who has just come into a big raise or exciting new salary or a more seasoned working veteran who has come to the conclusion that you have to make your money work for you. The latter, by the way, seems to be a growing category.
I've demonstrated elsewhere that under the conditions of fiat currency, money-based saving cannot be treated as a reliable store of your wealth . So, whatever the reasons behind your choice, choosing to invest is a wise decision.
Starting down the investor's path, a valuable bit of knowledge is how you can leverage market capitalization in your decisions. Previously (see the link at the bottom of this article) I have discussed its relevance and usefulness for informing investment decision making. Before those insights can be utilized, though, our terms have to be defined.
Just as it sounds, market capitalization invokes the total value that the market attributes to a company's capital. This value attribution, as we'll see, derives from the pricing of the company's shares. More precisely, the idea of market capitalization captures the market's valuation of a company's equity.
Equity is derived from adding together the total value of the assets (things owned by the company) and the subtracting from that number the total value of the liabilities (things owed by the company). A resulting positive number is the equity.
An illustration: Begin with a hypothetical company, we'll call it XXX. Its total assets (e.g., real estate, equipment, patents) add up to a total of $10 million. On the other side of the ledger, XXX's total liabilities (e.g. bank debts, settlement in a legal challenge, pending regulatory compliance costs) add up to a total of $4 million. The equity of XXX is then determined by subtracting the $4 million liabilities from the $10 million assets, revealing equity of $6 million.
Now, we already have to backtrack a little. When we spoke of the assets and liabilities as having a value, we were referring to the value attributed to those items on the books of the company. Its accountants have added this all together on the basis of prices that have been stipulated in the relevant contracts: either giving XXX ownership or making claims upon its property. This is called the book value.
Smart accountants will of course amend those figures to take account of facts such as depreciation. If machinery has been used for many decades, basing its book value on the price when newly bought misrepresents the value it would have if XXX wanted to sell it to another company, today.
This still, however, only addresses book value. The market's valuing of any company's equity is in no way beholding to its book value. Correspondence between the two can never be expected to either align or diverge. Though, experience shows that divergence is more likely.
Distinguishing between book and market value - not to mention recognizing its relevance to potential investors - profits from clarification of what market capitalization is and how it is determined. All price, naturally, emerge from markets by way of the interplay of subjective values. Every individual's unique, personalized preferences, mixes together to brew the stew of prevailing demand, which determines the relative scarcity of existing supply.
Shares in a company are a commodity sold on the market like any other. Except for the original public offering, when the shares of a company are first issued, they are sold (not to or from the company, but) between individuals not otherwise connected to that company.
Perhaps a simple analogy could help us, here. Imagine Tony selling an apple to Tom. Before this sale, Tony was the apple-holder. Subsequently, Tom became the apple-holder. With only this information, we don't know if Tony bought the apple directly from an apple farmer or from someone else, equally independent from the farmer - say Todd. In either case, though, in such situations (unless there is a special arrangement, such as Tony being an agent of the farmer) Tony has complete ownership of the apple and sells that complete ownership to Tom. Neither Tony nor Tom owes anything to the farmer who has already been paid for complete ownership of the apple by Tony or Todd, or someone else along the line.
It is the same with company shares: they are bought and sold just like the apple. And just as many factors go into determining the price of the apple at any point in time, so too is the case with the shares of a company.
We now can understand how market capitalization is derived. There is at any point in time a market price for the shares of company XXX. To determine the market capitalization the total number of shares issued by the company is multiplied by this price. The resulting figure is XXX's market capitalization.
If our hypothetical company XXX has issued one million shares and the market value of them is going at $6 each, we know that the market capitalization of XXX is $6 million. By happy coincidence, this just happens to be the book value of the company as we hypothesized it was calculated by XXX's accountants.
Such elegant symmetry, alas, is rarely the situation in the real world. This recognition, though, opens up the discussion to a whole other dimension. Why and how the almost certain discrepancy between book and market value of a company's equity comes to be is vital knowledge for aspiring investors. This though leads us to a more elaborate discussion of market capitalization.
I've demonstrated elsewhere that under the conditions of fiat currency, money-based saving cannot be treated as a reliable store of your wealth . So, whatever the reasons behind your choice, choosing to invest is a wise decision.
Starting down the investor's path, a valuable bit of knowledge is how you can leverage market capitalization in your decisions. Previously (see the link at the bottom of this article) I have discussed its relevance and usefulness for informing investment decision making. Before those insights can be utilized, though, our terms have to be defined.
Just as it sounds, market capitalization invokes the total value that the market attributes to a company's capital. This value attribution, as we'll see, derives from the pricing of the company's shares. More precisely, the idea of market capitalization captures the market's valuation of a company's equity.
Equity is derived from adding together the total value of the assets (things owned by the company) and the subtracting from that number the total value of the liabilities (things owed by the company). A resulting positive number is the equity.
An illustration: Begin with a hypothetical company, we'll call it XXX. Its total assets (e.g., real estate, equipment, patents) add up to a total of $10 million. On the other side of the ledger, XXX's total liabilities (e.g. bank debts, settlement in a legal challenge, pending regulatory compliance costs) add up to a total of $4 million. The equity of XXX is then determined by subtracting the $4 million liabilities from the $10 million assets, revealing equity of $6 million.
Now, we already have to backtrack a little. When we spoke of the assets and liabilities as having a value, we were referring to the value attributed to those items on the books of the company. Its accountants have added this all together on the basis of prices that have been stipulated in the relevant contracts: either giving XXX ownership or making claims upon its property. This is called the book value.
Smart accountants will of course amend those figures to take account of facts such as depreciation. If machinery has been used for many decades, basing its book value on the price when newly bought misrepresents the value it would have if XXX wanted to sell it to another company, today.
This still, however, only addresses book value. The market's valuing of any company's equity is in no way beholding to its book value. Correspondence between the two can never be expected to either align or diverge. Though, experience shows that divergence is more likely.
Distinguishing between book and market value - not to mention recognizing its relevance to potential investors - profits from clarification of what market capitalization is and how it is determined. All price, naturally, emerge from markets by way of the interplay of subjective values. Every individual's unique, personalized preferences, mixes together to brew the stew of prevailing demand, which determines the relative scarcity of existing supply.
Shares in a company are a commodity sold on the market like any other. Except for the original public offering, when the shares of a company are first issued, they are sold (not to or from the company, but) between individuals not otherwise connected to that company.
Perhaps a simple analogy could help us, here. Imagine Tony selling an apple to Tom. Before this sale, Tony was the apple-holder. Subsequently, Tom became the apple-holder. With only this information, we don't know if Tony bought the apple directly from an apple farmer or from someone else, equally independent from the farmer - say Todd. In either case, though, in such situations (unless there is a special arrangement, such as Tony being an agent of the farmer) Tony has complete ownership of the apple and sells that complete ownership to Tom. Neither Tony nor Tom owes anything to the farmer who has already been paid for complete ownership of the apple by Tony or Todd, or someone else along the line.
It is the same with company shares: they are bought and sold just like the apple. And just as many factors go into determining the price of the apple at any point in time, so too is the case with the shares of a company.
We now can understand how market capitalization is derived. There is at any point in time a market price for the shares of company XXX. To determine the market capitalization the total number of shares issued by the company is multiplied by this price. The resulting figure is XXX's market capitalization.
If our hypothetical company XXX has issued one million shares and the market value of them is going at $6 each, we know that the market capitalization of XXX is $6 million. By happy coincidence, this just happens to be the book value of the company as we hypothesized it was calculated by XXX's accountants.
Such elegant symmetry, alas, is rarely the situation in the real world. This recognition, though, opens up the discussion to a whole other dimension. Why and how the almost certain discrepancy between book and market value of a company's equity comes to be is vital knowledge for aspiring investors. This though leads us to a more elaborate discussion of market capitalization.
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All manner of investors need tokeep tabs on the hottest scoop on market cap. To know the score be sure to check us out at the Market Capitalization site.
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